ANALYSIS: Alaska reveals plan to regain financial strength

Alaska Air Group's top executives have finally laid out a plan they say will enable the company to regain the financial strength that eroded after its 2016 Virgin America acquisition.

"We have done a lot of the messiest work of the integration and it's now time… to really focus on market and financial performance," chief executive Brad Tilden tells investors during a presentation on 27 November. "We should be earning margins of 13% to 15% on pre-tax basis."

"That is an appropriate return," Tilden adds. "That is what we are attempting to do."

For two years, Alaska's top brass have urged investors for patience as the company worked through the integration of Virgin America, promising that the deal's benefits would ultimately pay off.

On 27 November, they finally provided solid details about those benefits and other measures aimed at returning Alaska to its previous glory.

Financial analysts welcomed the news.

"We sensed growing confidence in [Alaska's] ability to deliver results, with management noting confidence in reaching their targets irrespective of potential impacts from the broader environment," says Morgan Stanley in a research note on 28 November. "[Alaska] is set to deliver meaningful results into next year."

"Alaska Air Group management presented a credible plan to expand margins and grow earnings in ’19 and ’20," says a report from investment bank Evercore ISI.

Alaska's presentation comes almost two years after Alaska's $4 billion purchase of Virgin America in December 2016 – a deal some investors worried would distract a company that had long returned industry-leading financial results. In both 2015 and 2016, Alaska earned net profits of more than $800 million and pre-tax margins of 24%.

But its results started slipping in 2017, a trend that continued into early 2018. In the first quarter of this year, for instance, Alaska posted a net profit of only $4 million.

"There has been a lot of change to our business and… our financial results have deteriorated," says Alaska's executive vice-president of planning and strategy Shane Tackett.

"The biggest piece has been fuel," Tackett adds, noting fuel prices jumped 85% in the last 12 quarters.

Investors grew frustrated and impatient as Alaska's financial returns soured, and the price of the company's stock slipped nearly 40% since late 2016.

But on 27 November, Alaska gave investment analysts what they long sought: a detailed recovery path. The plan rests partly on Alaska's expectation that in 2019 it will finally start reaping significant rewards from its integration of Virgin purchase. The company also laid out cost cutting and revenue generating initiatives.

Alaska says 80% of the potential value created by merger "synergies" remain untapped – good news for a company looking for a significant financial boost.

The airline will start achieving much of that untapped value in 2019 as works toward "cross fleeting", or integrating its Boeing 737 network with its Airbus A320 network and deploying both types across the combined network as efficiently as possible.

Replacing an A320 with a 737-900ER between Los Angeles and New York, for example, can generate an additional $2,500 per flight, says chief commercial officer Andrew Harrison.

The company is also updating the cabins of A320-family aircraft to have four additional seats and more first class seats – moves that could generate an additional $550 on a flight between Los Angeles and Seattle, Harrison says.

Merger synergies will eventually generate an additional $235 million in annual revenue, the company estimates.

Alaska's recently introduced basic economy fare, additional corporate sales and fees for checked luggage and seat selection will eventually generate another $240 million in annual revenue, it says.

Some of those measures appear to be paying off already, Alaska hiked its fourth quarter unit revenue forecast by nearly 2% to 12.60-12.80 cents.

Evercore estimates Alaska's revenue per available seat mile (RASM) in 2019 will increase in the "mid-single digit" range year-over-year.

Alaska also tells investors it aims to save $75 million annually through operational efficiencies and another $85 million annually by cutting overhead and other expenses. Alaska's intention to slash overhead became evidence in October when news broke that it was cutting some 100 management jobs.

Alaska now expects its 2019 cost per available seat mile (CASM), excluding fuel and special item expenses, will inch up only 2-2.5% year-on-year.

By comparison, Alaska's 2018 unit cost will increase 3.2% year-on-year, the company says.